Don’t Buy This Stock Now, but Don’t Ignore It Either

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The going has been tough for Analog Devices (NASDAQ: ADI) this year as the recovery it had hoped for seems to be happening very slowly. The company, which provides analog, mixed-signal, and digital signal processing integrated circuits to various end-markets such as industrial, automotive, communications etc., has disappointed investors with a modest return of around 8% through stock price appreciation.

This is not surprising when you consider that Analog has posted two disappointing quarters this fiscal year and its outlook has not been up to the mark on both occasions, indicating that the sluggishness in its business would continue.

Unimpressive, once again

The recently-released second-quarter report didn’t inspire much confidence either as except automotive, all other end-markets declined from the year-ago period. As a result, total revenue fell 2% from last year to $659 million, short of the analyst estimate of $660.4 million, which was already low after the company had issued a sorry outlook in its first-quarter report. And as far as the bottom line is concerned, Analog Devices missed estimates once again, posting earnings of $0.50 per share while the Street expected $0.52 a share.

The outlook is below expectations. The company expects revenue between $655 and $685 million in the ongoing quarter, way behind the consensus estimate of $688 million at the mid-point as all of its end-markets, except Industrial, are expected to be flat.

Mixed cues

However, it should be noted that the company witnessed sequential improvements in its business in the last quarter and the trend is expected to continue in the current one. Growth in instrumentation and industrial automation pushed up Industrial revenue by 11%, while strong vehicle sales in China and the U.S. had a positive effect on Analog’s automotive end-market, which grew 14%.

The company is counting on more electronic content in vehicles and has positioned itself to benefit from this trend through its strong product portfolio that serves the automotive market. In the industrial market, Analog witnessed strong order rates as demand matched supply. Inventory at its distribution partners remained low, which indicates that demand for industrial products is in good health.

A similar sentiment was echoed by Analog Devices’ competitor, Texas instruments (NASDAQ: TXN), on its earnings call last month. Texas Instruments’ management pointed out that its customers were keeping lean inventories, which signifies that demand for its products has been picking up. However, the company was still cautious about demand but its outlook was slightly ahead of estimates.

Now, Analog Devices is intent on making the most out of the industrial market and it has been focusing its product development initiatives toward this sector. With the possible rise in demand going forward as deduced from the commentary of the two chipmakers, the industrial business, which accounts for almost half of Analog’s revenue, should gain strength.

But then, Analog’s communications businesses might continue to be sluggish, at least in the short-term. The company believes that the roll out of faster networks and capacity expansion of network infrastructure will drive its communications business in the long run. However, this will only happen when telecom carriers open their wallets generously, which doesn’t seem to be the case at the moment.

For instance, AT&T (NYSE: T) lowered its capex estimates for 2014 and 2015 by $2 billion for both years. The telco giant cited the faster roll out of its LTE network and better efficiency in Project Velocity IP as reasons behind the lower spending forecast, but eventually, lower capex plans of a telecom carrier isn’t good news for equipment providers and component suppliers.

Similarly, Verizon had stated earlier this year that it would keep spending flat this year as compared to last year due to an uncertain macro environment. Thus, even though the communications market would probably benefit from secular growth trends in the future, the near-term outlook isn’t quite encouraging.

What should you do?

Analog Devices has had a pretty good run over the past one year and this has sent its valuation to expensive levels. A trailing P/E of around 21 doesn’t make it attractive even though a dividend yield of 2.90% might be tempting. Thus, it would be prudent for investors to wait for a decent pullback before initiating a long position in Analog Devices as the company looks good for the long run, but it seems expensive right now.

Harsh Chauhan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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